Personal guarantee insurance protects a percentage of business owners' personal assets if they default on a loan with a personal guarantee.
Personal guarantee insurance does not seem to be currently available in the U.S.
What Is Personal Guarantee Insurance?
Many small businesses need financing in the form of a business loan to get started or to expand. Since a new business often has little collateral and little to no income to guarantee the loan, the business owner is often required to provide a personal guarantee.
A personal guarantee is signed by the business owner and pledges personal assets in the event of business default—that is, the owner's assets may need to be sold to pay off the business loan.
Personal guarantee insurance (PGI) provides small-to-medium-sized business owners and commercial real estate investors protection for personal assets when they sign a personal guarantee for a commercial loan.
- Acronym: PGI
How Personal Guarantee Insurance Works
Personal guarantees have long been a fact of life for business owners seeking a commercial loan, but this doesn’t lessen the risk associated with signing them. By doing so, the business owner (also known as a guarantor) is responsible for satisfying the loan terms in the event of the business’ liquidation. This puts the guarantor’s assets (such as a home, car, college accounts, retirement accounts, etc.) at risk. PGI is designed to protect the guarantor’s assets in such a situation.
If, after liquidating the business assets, the lender seeks personal assets to repay the balance of the loan, PGI will cover up to 70% of the insured’s net liability, depending on the coverage purchased and the terms of the policy.
By covering up to 70% of the guarantor’s net liability, PGI provides the insured with a safety net without eliminating the motivation to overcome difficulties and restore the health of the business.
PGI is an annual policy with a premium based on the size of the loan and the risk characteristics of the underlying business. Coverage is generally only available for a limited time after the loan closing.
Benefits of Personal Guarantee Insurance
PGI is designed to protect the borrower’s assets when signing a personal guarantee. However, coverage benefits can be assigned to the lender, and lenders may be willing to provide a lower interest rate if this coverage is purchased when the loan is originated.
Coverage amounts are typically up to 70% of the stated value of a personal guarantee, at the discretion of the guarantor, up to a policy limit established by the insurer. Coverage may be written for most commercial and industrial loans, including lines of credit, demand loans, term loans, commercial real estate, term facilities, and commercial mortgages.
Alternatives to Personal Guarantee Insurance
Business owners aren't required to purchase personal guarantee insurance when they take out a loan. Some may find that the premiums are cost-prohibitive or that they don't qualify. That does mean their personal assets are at risk, so it's essential to be mindful of the risk being taken. Many business owners are unable to get a business loan without a personal guarantee, though.
One alternative is working with business partners to secure funding. If there are multiple partners, they may qualify for a loan with a limited personal guarantee. This puts a dollar limit on what can be collected from the borrower in the event of a default. A several guarantee assigns a set percentage of liability from each partner. A joint and several guarantee allows the lender to recover the full amount borrowed from any partner, so it's best to avoid this type of limited guarantee, if possible.
Collateral can also be used as an alternative to a personal guarantee, negating the need for personal guarantee insurance. Business owners can pledge specific assets or sets of assets, and if they're unable to repay the loan, lenders can seize and sell the collateral to pay off the loan. Collateral can be real estate, inventory, cash, or anything else of value.
If you're not sure what funding option to go with, the Small Business Administration (SBA) offers free consulting. Contact your local office for assistance.
- Personal guarantee insurance protects a percentage of business owners' personal assets if they default on a loan with a personal guarantee.
- Many business owners take out loans with personal guarantees to fund starting or growing a business.
- Personal guarantee insurance pays a percentage of the liability if the business owner defaults on a loan.
- It can be assigned to a lender, which may result in a lower interest rate on this loan.
- Alternatives to personal guarantee insurance include bearing all the risk, sharing it with business partners, and pledging specific collateral.